There are many
different cycles that operate over many different time frames. An
example would be a 12-month rate of change (ROC) indicator. It only
reflects a limited number of cycles associated with the set 12-month
timeframe. It occurred to me that an indicator that combines several
different time spans could offer better results. Also, the raw ROC
indicator can be quite jagged, so one- or two monthís data could easily
give you a false sense of a trend reversal. A smoothed version of the
ROC might also prove useful in identifying trend reversals. For these
reasons, I developed a smooth summed rate of change indicator called the
KST.

Tired of hearing
market forecasters talking about their indicators as if they were
guaranteed to make the user rich, I called it the KST,
because it stands for ďKĒnow ďSĒure ďTĒhing. Iíve
learned after all my years trading that nothing is a sure thing, but the
indicator does offer a good charting rendition of the economic growth
path that revolves around the business cycle. Actually, the concept of
a summed rate of change is not new. Joseph Schumpeter used it in his
classic book, Business Cycles (McGraw Hill 1939).
My friend, Ian Notley of Yelton Fiscal, adopted this concept for his own
cycle work and gave me the idea to develop my own formula.

The table below shows
how the KST formula is calculated, along with the corresponding time
frames for monthly data.

Rate of
Change

Smoothing
Factor

x

Weighting

=
Total

9-month ROC

6-month MA

x

1

6

12-month ROC

6-month MA

x

2

12

18-month ROC

6-month MA

x

3

18

24-month ROC

9-month MA

x

4

36

KST
=

72

The KST concept was
originally derived for long-term trends, but the idea of four (4)
smoothed summed ROCs can easily be applied to short-, intermediate-, and
even intraday trends. Iím not suggesting they are the best parameters
that can be devised; itís very likely they can be improved. It is
important though to bear in mind that most of us are looking for perfect
indicators, which is an unrealistic Holy Grail. The best anyone can
hope for is reasonable consistency, and thatís my objective with the KST.

Chart 1

The formula for the
long-term KST assumes the series being plotted experiences cyclic
rhythms associated with the business cycle. This means that when a
linear up or down trend is experienced, the KST, like any momentum
indicator, gives false or excessively premature signals. A mild failed
signal developed in Chart 1 during the 2000/01 period. Fortunately,
linear trends are the exception, rather than the rule. Recent examples
include the Japanese stock market in the 1970ís and 1980ís, and U.S.
equities in the 1980ís and 1990ís. Also, since the indicator involves
several moving averages, the KST is not affected by sudden and/or sharp
turns, such as those associated with the 1987 crash or the decline in
the Hong Kong equity market immediately following the Tiananmen Square
massacre in 1989.

KST signals are
triggered either when the series changes direction, or the indicator
crosses its 9-month moving average (MA). The red and green highlights
in Chart 1 indicate when the KST is below or above the dashed red line;
i.e., the 9-month MA.

KSTs occasionally
throw up positive and negative divergences, as well. A positive
divergence developed between 1999 and 2002, when the Index moved lower
but the KST bottomed out at a higher level (this has been is flagged on
the chart by the two green arrows.) Overbought and oversold zones can
also be constructed and used to indicate when the price series in
question is close to its normal overbought level. Like all momentum
series, KST signals should be confirmed by some kind of a trend
reversal confirmation from the series it is monitoring. After all,
we are buying and selling the price, not the momentum, and price
occasionally experiences a linear trend that does not conveniently fall
into the usual business cycle rhythm assumed by the KST formula.